Last year was a bumper one for the bond market in Europe, with more than €195bn of investment-grade corporate debt priced in euros, 93% up on 2011’s tally, according to Societe Generale.

In the first half of the year, and for the first time ever, European corporate bond supply exceeded borrowing in loan format, according to Fitch, with 52% of new borrowing done in the bond market, compared with an average of 29% since the launch of the euro.

“Disintermediation”, or borrowers’ move away from reliance on loan financing in favour of the bond market, is already a fact of life, according to market participants. The move away from loans has come largely amid fears that banks might be unwilling or unable to provide them in the new regulatory environment.

Martin Egan, global head of primary markets and origination at BNP Paribas, said the process would take time but was already firmly established. He said: “Most mature investment-grade companies have predominantly funded in bond rather than bank markets over the last few years. They tend to use the bank market for shorter-term liquidity and the bond market for anything longer, namely five to seven years plus.”

Bankers point out that a lot of bank loan financing is in the form of undrawn facilities – credit lines that corporate borrowers have arranged with banks for a fee but not actually used. Drawn funding, referring to credit lines that have been drawn down and used, is being replaced in the bond market.

However, this can be a difficult trend to spot, believes Mark Lewellen, head of European corporate syndicate at Barclays. He said: “You won’t pick up that trend in any of the statistics because unless you’re the agent on a loan or a lender you’re never going to know how much is drawn and how much isn’t.” While the usual narrative is that borrowers are opting for bond financing because capital constraints make it difficult for banks to lend, Lewellen sees it as a question of relative value.

He said: “Loan margins have crept up from the tights at a time when bond market pricing is probably at an all-time low in investment grade. We’ve seen five-year drawn bank debt priced at similar levels as a 10-year bond so it’s quite easy if you’re a corporate treasurer or chief executive to persuade your board to diversify into the bond market. A few years ago the economics didn’t work quite so well.”

But while debt bankers are confident that the move to bonds is happening, few believe that 2013 will show a decisive shift in investment-grade markets because issuers did so much last year and have no need for more funding.

Nicholas Bamber, head of investment-grade corporate DCM at RBS, said: “Issuance will likely drift south in 2013 relative to 2012 simply because corporates have a limited use for the proceeds.”

In its outlook for the year, Societe Generale predicts that European investment-grade issuance will fall by 34%, but expects high-yield borrowing to be up by about 10% in 2013.

Demetrio Salorio, Societe Generale’s head of DCM, said: “We will see an increased number of borrowers issuing debt capital markets transactions for the first time, including high yield. Disintermediation will continue and companies will continue to think capital markets when they think strategic financing. From that standpoint we expect a pretty intense year in terms of credit work and new names.”

Investors see this as well, with David Fancourt, a credit fund manager at M&G Investments, noting that, while he expects nothing decisive this year, “the high-yield market is certainly maturing while the loan buyer base declines”.

Third-party loans

Although European high-yield issuers are making the transition from loans to bonds, they still remain reliant on the deeper US market for that bond issuance. Last year, the US market accounted for 36% of issuance by volume by European high-yield companies, only 15 percentage points behind issuance in euros, according to SG. Although some had seen this as a permanent feature of the market, others believe that when the pricing dynamics making dollar funding attractive change, so too will the extent to which European high-yield issuers fund in the currency.

Melissa Smith, head of high-grade corporate DCM for Europe, the Middle East and Africa at JP Morgan, is one of them. She said: “There has been a pricing arbitrage which, along with the deeper capacity, has attracted European issuers to the dollar market,” she said.

“But as that dissipates – and we’ve seen that in the last few months amid concerns over the fiscal cliff – European issuers will likely stick to the European market. There is capacity and demand, especially as investors are willing to move down the ratings spectrum in search of yield.”

Most of the discussion about the future of corporate debt finance is restricted to two scenarios – one where the banks provide direct loans and another where they arrange bond deals. But there is a third option, where the buyside circumvents both.

Bankers report instances of the largest and most sophisticated investors approaching companies directly with a view to lending in syndicated loan format on terms that bank lenders are used to, such as additional covenants.

While this is something that he believes could build momentum, Barclays’ Lewellen sees only the initial signs of this and is confident that third-party lending is no substitute for the bond markets.

Lewellen said: “It’s another complementary source of funding. We see companies issuing bonds at the same time they do US private placements, while they’re also establishing syndicated loan facilities.”
Bankers see the bond versus loans argument in a similar vein. Rather than a chalk-and-cheese situation, they advise their corporate clients to see both as components of the arsenal at their disposal, with an increasing focus on bonds as banks pass on their own heightened borrowing costs.

It’s a trend that Egan at BNP Paribas sees as long term, “rather than zero to 60 in three seconds”.
He said: “We’ll see more new issuers in Europe next year. If you’ve been using a certain funding strategy for 20 or 30 years, it’s not going to be an overnight change, but if you did a straw poll of the top 50 investment-grade corporates in western Europe, you’d see a much bigger weighting to bond financing.”